by Marilyn Miller
Neither a borrower nor a lender be, For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.
-William Shakespeare, Hamlet Act 1, scene 3
Marilyn “Mara” Miller is committed to small businesses. For over a decade, she has been a strong advocate for her clients. She not only helps customers recover money due to them, but also works to strengthen their credit practices and procedures.
Mr. Shakespeare’s advice may be wise, but he was obviously not a small businessperson! In today’s entrepreneurial world, a certain amount of both borrowing and lending will likely be necessary. Here is some advice to help you decide how much your small business can afford to borrow, and how much credit you can afford to extend to your customers.
Even if you are fortunate to have cash on hand when you start a business, you will want to establish a line of credit with your bank, and use the capital to grow in line with your strategic business plan (you do have one, right?).
Certain equipment is vital to your operation, while some is needed as you expand. Flexing your line of credit muscle, especially if you can negotiate an attractive rate, will make you money, as increased efficiency will make you more competitive.
Similarly, you should make a determination how much credit you are willing to extend to customers. Determining your “risk tolerance”, or customer credit limit, is an important step. It is not only a question of how much credit you will extend, but how long you are willing to extend it.
If you do not have a business relationship with a bank, you may be asked to personally guarantee the money you borrow. This is not out of the ordinary and could be a good practice to implement with your credit customers. Have your attorney review any contracts before you sign them though.
Credit limits are as individual as each small business, and range from full payment up front to extended payment plans. Your risk tolerance should be based on the following factors:
1. Cash flow – Your ability to keep current with your expenses.
2. Competition – What are your competitors doing? If you expect cash up front, and your competitor down the street gives payment terms, how will you compete?
3. Staffing – Payment plans should always be documented and tracked. Do you have the time to do that, or someone to do it for you?
4. Clientele – The types of customers you have could impact how much credit you extend. You might deem a local client a better risk than one in another state. You could decide to extend credit to those who will supply repeat orders but not to “one and done” customers.
5. Credit worthiness – If you are willing to extend credit to someone, they should be willing to provide you with business and bank references. Verify them before making any decisions.
6. Personal guarantee – The failure rate of small businesses is astounding. If your client is a small business, you may want to ask them for a personal guarantee before you extend credit. A personal guarantee means that the borrower would be personally responsible for a debt if the company were to go out of business. Your bank would ask you to guarantee a loan, so be more like a bank!
In summary, there is no perfect formula for how much you should borrow, or how much you should lend. But knowing what you can afford while still being able to grow is a great first step. The right plan is the one that is right for you.
